{"id":16941,"date":"2021-07-08T09:12:16","date_gmt":"2021-07-08T09:12:16","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=16941"},"modified":"2026-02-10T07:02:06","modified_gmt":"2026-02-10T07:02:06","slug":"beta-estimation","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/beta-estimation\/","title":{"rendered":"Beta Estimation"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Which of the following processes is most likely to be applied to an asset beta to reflect the effect of financial leverage when estimating the beta of a nonpublic company?\",\r\n    \"text\": \"Which of the following processes is most likely to be applied to an asset beta to reflect the effect of financial leverage when estimating the beta of a nonpublic company?\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is B. Re-levering is the process of incorporating the effect of the subject company\u2019s financial leverage on an asset beta.\\n\\nA is incorrect. Adjusted beta is the estimated beta that reflects the tendency of betas to revert to 1.0 over time.\\n\\nC is incorrect. Unlevering is the process of eliminating the comparable company\u2019s financial leverage from its beta so that it only reflects systematic risk. This process is used to arrive at the asset beta.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/UnwokOxe4OM\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<h2>Beta Estimation for a Public Company<\/h2>\r\n<p>For public companies, beta is estimated through ordinary least squares (OLS) regression of the returns on a stock on the returns on the market. Beta estimates from such a regression are influenced by the following:<\/p>\r\n<ul>\r\n\t<li>The choice of index used to represent the market portfolio. For example, for U.S. equities, the S&amp;P 500 index is used as the market portfolio.<\/li>\r\n\t<li>The length of the data period and the frequency of observations. The most common choice is five years of monthly data, yielding 60 observations.<\/li>\r\n<\/ul>\r\n<p>The value of beta obtained through OLS regression is known as <em><strong>raw<\/strong><\/em> or <em><strong>unadjusted<\/strong> <strong>historical beta<\/strong><\/em>. Betas have tended to revert toward 1.0 over time, and since valuation is forward-looking, raw betas are adjusted so that they more accurately reflect future betas.<\/p>\r\n<p>$$\\text{Adjusted beta}=\\bigg(\\frac{2}{3}\\bigg)(\\text{Unadjusted beta})+\\bigg(\\frac{1}{3}\\bigg)(1.0)$$<\/p>\r\n<!-- TOP CTA \u2013 Full Width Outline Button -->\r\n<div style=\"margin:24px 0;\">\r\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\"\r\n     target=\"_blank\"\r\n     rel=\"noopener noreferrer\"\r\n     style=\"\r\n       display:block;\r\n       width:100%;\r\n       padding:14px 0;\r\n       border:2px solid #3b6fd8;\r\n       border-radius:50px;\r\n       font-size:18px;\r\n       font-weight:500;\r\n       text-align:center;\r\n       text-decoration:none;\r\n       color:#3b6fd8;\r\n       background-color:#f4f6f9;\r\n       box-sizing:border-box;\r\n     \">\r\n     Practice beta estimation questions with free trial access.\r\n  <\/a>\r\n<\/div>\r\n\r\n<h2>Beta Estimation for Thinly Traded Stocks and Nonpublic Companies<\/h2>\r\n<p>Analysts can indirectly estimate the beta of nonpublic companies using the beta of publicly traded comparable companies. This procedure must consider the effect on the beta of differences in financial leverage between the nonpublic company and the comparable. This is done in two steps:<\/p>\r\n<p><em><strong>Step 1<\/strong><\/em><strong>:<\/strong> The comparable company&#8217;s beta is unlevered to reflect the systematic risk. This is known as <strong>asset beta<\/strong> (\\(\\beta_{U}\\)).<\/p>\r\n<p>$$\\beta_{U}=\\bigg[\\frac{1}{1+\\big(\\frac{\\text{D}}{\\text{E}}\\big)}\\bigg]\\beta_\\text{E}$$<\/p>\r\n<p>Where \\(D\\) and \\(E\\) represent the nonpublic company\u2019s debt and equity levels.<\/p>\r\n<p><em><strong>Step 2<\/strong><\/em><strong>: <\/strong>The unlevered beta (asset beta) is then re-levered to reflect the financial leverage of the comparable company.<\/p>\r\n<p>$$\\beta_{\\text{E}}=\\bigg[1+\\frac{\\text{D}}{\\text{E}}\\bigg]\\beta_{U}$$<\/p>\r\n<p>Analysts may use the median or average industry beta rather than a single comparable company&#8217;s beta. The un-levering and re-levering process can be applied to the asset beta using the median or average industry capital structure.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following processes is <em>most likely<\/em> to be applied to an asset beta to reflect the effect of financial leverage when estimating the beta of a nonpublic company?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>Adjusted beta.<\/li>\r\n\t<li>Re-levering.<\/li>\r\n\t<li>Unlevering.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is B.<\/strong><\/p>\r\n<p>Re-levering is the process of incorporating the effect of the subject company\u2019s financial leverage on an asset beta.<\/p>\r\n<p><strong>A is incorrect.<\/strong>\u00a0Adjusted beta is the estimated beta that reflects the tendency of betas to revert to 1.0 overtime.<\/p>\r\n<p><strong>C is incorrect. <\/strong>Unlevering is the process of eliminating the comparable\u2019s company financial leverage from its beta so that it only reflects the systematic risk. This process is used to arrive at the asset beta.<\/p>\r\n<\/blockquote>\r\n<p>Reading 21: Return Concepts<\/p>\r\n<p><em>LOS 21 (d) Explain beta estimation for public companies, thinly traded public companies, and nonpublic companies.<\/em><\/p>\r\n\r\n<!-- BOTTOM CTA \u2013 Refined Version -->\r\n<div style=\"text-align:center; background-color:#f4f6f9; padding:35px 20px; border-radius:12px; margin-top:40px;\">\r\n\r\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\"\r\n     target=\"_blank\"\r\n     rel=\"noopener noreferrer\"\r\n     style=\"\r\n       display:inline-block;\r\n       padding:14px 34px;\r\n       background-color:#3b6fd8;\r\n       color:#ffffff;\r\n       border-radius:50px;\r\n       font-size:16px;\r\n       font-weight:600;\r\n       text-decoration:none;\r\n       margin-bottom:18px;\r\n     \">\r\n     Start Free Trial\r\n  <\/a>\r\n\r\n  <p style=\"max-width:700px; margin:0 auto; font-size:16px; line-height:1.6; color:#333;\">\r\n    Sharpen CFA Level II equity skills with exam-style beta estimation problems, clear explanations, and timed practice that helps you apply regressions and adjustments confidently.\r\n  <\/p>\r\n\r\n<\/div>\r\n","protected":false},"excerpt":{"rendered":"<p>Beta Estimation for a Public Company For public companies, beta is estimated through ordinary least squares (OLS) regression of the returns on a stock on the returns on the market. Beta estimates from such a regression are influenced by the&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,401],"tags":[422,216,402,423],"class_list":["post-16941","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-equity-valuation","tag-beta-estimation","tag-cfa-level-2","tag-equity-valuation","tag-reading-25-return-concepts","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Beta Estimation - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"For public companies, beta is estimated through ordinary least squares (OLS) regression of the returns on a stock on the returns on the market.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/beta-estimation\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Beta Estimation - 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